MyCIMA

Standard costing system - driven by what?

Replies : 3

I think its important to understand the objectives for choosing a standard costing system. I feel this is required

a) Implement the budgets and forecasts

b) Get an estimate of cost of finished goods using cost rollup

c) Facilitate  pricing of finished goods by stripping off certain cost elements

d) And of course to assess performance of underlying business functions driving costs.

Lot of modern thinking has been questioning the relevance of a standard costing system in today's dynamic business environment. Standard costing system is often doubted whether it directs correct organizational behaviour. Is there a too much focus on conformance to standard cost vs focussing on adding value..

Well I think fundamentally we need to question why organizations prepare budget. Business needs a benchmark to validate its strategy and business decisions. And budget is one tool which translates the strategy and business decisions of a business. Standard costing goes one level below into operational execution of the strategy and business decisions. It executes the budget and tracks the reality.

So can we do away with the budgeting and planning process? How many organizations do not want to have budgets? Yes there are instances where companies have budget but do not follow standard costing. But yet there is a rough benchmark against which things are compared.

I would love to have more perspectives on this topic and why modern thinking is against standard costing. 

standard costing

most of questions that the examiner seem to focus on regarding standard costing are limitations of standard costing in the modern business environment Standard cost is a benchmark used for resource usage. 1) Due to increase in quality and customised products it is difficult to use standard costing in the modern business environment 2)Standard costing is expensive and time consuming and require to be revised regularly. 3) Standard costing can work in a stable environment hence it is not easy to use in the modern business environment which is more dynamic and prone changes .

Standard Costing and the Modern World

Shyam

Have a look at my earlier discussion on "What is Lean Accounting" for a review of the problems with standard costing in the modern age. Basically standard costing was designed for a mass production environment where there was low product variability and the producer could sell everything they made. These tenets no longer stand. Organisations now have very complex product and service offerings, often tailored to individual customer needs; and firms can longer be sure of selling everything they produce. Standard costing then begins to break down and starts giving us false information and leading decision making in the wrong direction - for example to reduce variances firms will often build stock (inventory) at the end of an accounting period. This boosts their standard cost performance but does nothing for the organisation except tie up cash in depreciating stock, tie up production which could be used for more useful things, and create problems further down the road (like how do we get rid of all this stock = discounts and other non profit maximising activity).

At the same time standard costing tells us nothing about resource utilisation and efficiency - partly for the reasons noted above and partly because resource efficiency is nothing to do with the "efficiency" of individual steps in the process, but about the flow of the whole process. Also standard costing assumes that labour time and machine time are variable, in fact they are not. You have the people and the machines and you are paying for them anyway. It may be profitable to take a job at below standard cost because you have capacity in the process to make it and, thus, the incremental cost of making that job is only the materials cost (and energy).

And standard costing tells us nothing about how effectively we are serving the customer and creating value for them.

Modern businesses need an accounting system that tells them about customer value; that looks at the capacity and efficiency of the whole process (not just individual stages); and looks at wider and more understandable performance measures than just variances. Standard costing is no help there.

Ross Maynard

Standard costing, average/actual costing and cost object

Thanks Ross for an insightful note. I also read your note on 'What's Lean Accounting?'. I do agree that traditional cost accounting systems is focussed on meeting the financial reporting requirements and less towards management accounting and decision support. So fundamentally there is a new paradigm where we need to obsolete the following:

a) Product as a cost object - Since modern production planning is towards adopting JIT and Lean approaches, we do not have the need to maintain stock registers and report on-hand quantity and value accurately. Hence there is no need to have 'Product' as a cost object.

b) Allocation of indirect costs to product or any other cost object
It is non-value added accounting and does not reflect the 'cost object's' performance

The other point is We also have other cost methods to value inventory. Like Perpetual Average Costing, FIFO/LIFO costing. Even in these cost methods, we have the practice of allocating overhead costs to 'Product' cost object, which is no different from what we are doing in standard costing. Where do you see the relevance of these cost methods given that 'Product' cost object and Inventory Valuation per se are least significant in modern world? There are industries where maintaining stock is inevitable. In such cases we do require a cost method to value inventory. So I guess 'Product' cost object is still valid and standard and non-standard cost method do come into play for statutory financial reporting.